This country-specific Q&A provides an overview to tax laws and regulations that may occur in China.
This Q&A is part of the global guide to Employee Incentives. For a full list of jurisdictional Q&As visit http://www.inhouselawyer.co.uk/practice-areas/employee-incentives/
What kinds of incentive plan are most commonly offered and to whom?
The incentive plan could be offered in various kinds, while most commonly used incentive plan forms are share options and restricted shares. Ordinarily, the incentive plan are offered to the management, key employees of the company, some companies provide equity incentive plans for ordinary employees and exterior consultants, while year-end bonus and performance-based bonus are usually offered to all or most employees.
What kinds of share option plan can be offered?
Restricted Shares, Share Options, Stock Appreciation Right, Phantom Stock, Performance Share Plan, Performance Unit Plan etc.
What kinds of share acquisition/share purchase plan can be offered?
Restricted Shares, Performance Share Plan.
What other forms of long-term incentives (including cash plans) can be offered?
The long-term incentives including but not limited to the following forms, signing bonus, deferred bonus, household registration quota, usage or ownership right of the house or car, supplementary pension, occupational pension, interest-free loan, professional training, etc.
Are there any limits on who can participate in an incentive plan and the extent to which they can participate?
Companies have the discretion to decide who can participate in an incentive plan and the extent to which they can participate under their articles of associations and director resolutions. Administrative Measures for the Equity Incentives of Listed Companies has certain requirements regarding the recipient of the incentive plans: Article 8 Equity incentives may be granted by a listed company to its directors, senior officers, key technical staff or key business staff, as well as other employees considered by the company to have a direct influence on its business performance and future development, with the exception of independent directors and supervisors. Foreign employees in the position of director, senior officer, or member of the key technical or the key business staff of the listed company may also be granted equity incentives. Shareholders holding, individually or in aggregate, 5% or more of the shares or actual controllers of a listed company and their spouses, parents or children may not be granted equity incentives. Additionally, the following persons may not become incentive recipients: 1. anyone who has been identified by a stock exchange as an inappropriate recipient during the most recent 12 months; 2. Anyone who has been identified by the CSRC or any of its agencies as an inappropriate recipient during the most recent 12 months; 3. anyone who have been subject to administrative penalties or been denied market access by the CSRC or any of its agencies due to a gross violation of laws and regulations during the most recent 12 months; 4. anyone not allowed to take the position of director or senior officer of listed companies under the Company Law; 5. anyone prohibited by laws and regulations to participate in the equity incentive plans of listed companies; or 6. any other persons as specified by the CSRC.
Can awards be made subject to performance criteria, vesting schedules and forfeiture?
Yes, companies have the discretion to decide performance criteria, vesting schedules and forfeiture under the employee incentive plan that apply to awards. The creation of the incentive plan could be discussed in the meeting of the employees or the employee representatives and the incentive plan and opinions could be rendered and equal consultations with the workers’ union or the employee representatives shall be made. Such incentive plan shall be approved by the meeting of shareholders and board of directors or other authorities stipulated in the articles of association of the company, and the public notice or the notice to the vestees should be made.
What are the tax and social security consequences for participants in an incentive plan including: (i) on grant; (ii) on vesting; (iii) on exercise; (iv) on the acquisition, holding and/or disposal of any underlying shares of securities; (v) in connection with any loans offered to participants (either by the company operating the incentive plan, the employer of the participant (if different) or a third party) as part of the incentive plan.
Since there are various forms of incentive plans, we take stock options here as an example,
(i) on grant;
Circular of the Ministry of Finance and the State Administration of Taxation on Issues Concerning the Imposition of Individual Income Tax on Incomes from Individual Stock Options (Cai Shui  No. 35) stipulates that "when participants accept stock options granted by companies implementing stock option plans, unless otherwise specified, Not taxed as taxable income."
No social security consequence.
(ii) participant on exercise;
unlisted company (a)If the participant directly holds the shares in the unlisted company:
Normally the participants shall pay individual income tax which is taxed as “the wage and salary income”, which is 3%-45% progressive tax rate.
However, if a unlisted company satisfies the conditions stipulated in Circular on Improving Income Tax Policies relating to Equity Incentives and Technology Shares (hereinafter referred to as “No. 101 Document”), a deferred tax policy may be implemented. That is, taxes will be deferred until the transfer of equity, and the income tax will be calculated at the 20% tax rate of “property transfer income”. During the period of deferred tax payment, if the relevant circumstances of the enterprise change, it will no longer meet the conditions for enjoying the deferred tax preferential policy, such as item 4 (scope of incentives), item 5 (time of holding shares) or item 6 (Exercise time), the equity incentive plan will no longer apply the deferred tax policy, and the relevant taxes should be paid in time.
(b)If the participant indirectly holds the shares of the company via one limited liability partnership, then the participants shall pay their respective individual income tax for their ratio in such limited liability partnership.
(c) If the participant hold the shares in A-share listed company, when an participant exercises his right, if the actual purchase price (exercise price) at which an participant gets stocks from his enterprise is lower than the fair market price on the purchase day (which refers to the closing price of stocks on that day, similarly hereinafter), the difference is the incomes relating to his service and employment due to his performance and accomplishments in this enterprise, therefore, the individual income taxes on such kind of incomes shall be imposed pursuant to the provisions on "incomes from wages and salaries". If, under special circumstances, a participant transfers his stock options prior to the exercise day, the net incomes from the transfer shall be the basis for calculating the individual income taxes on his income from wages and salaries. For the incomes from wages and salaries of a participant obtained during the exercise day, the taxable income from wages and salaries shall be computed pursuant to the following formula: taxable income from wages and salaries in the form stock options = (market price per stock of stocks to be exercised – exercise price per stock paid by a participant for the said stock options) x amount of stocks. Besides, as stipulated in Circular on Matters Concerning Connection of Relevant Preferential Policies After the Revision of the Individual Income Tax Law, for those with conditions satisfy the Circular of the Ministry of Finance and the State Administration of Taxation on Issues Concerning the Imposition of Individual Income Tax on Incomes from Individual Stock Options, Circular of the Ministry of Finance and the State Administration of Taxation on Relevant Issues Concerning the Collection of Individual Income Tax on Income Derived from Stock Appreciation Rights and Restricted Stocks, Article 4 of Circular on Promoting the Pilot Tax Policies on National Independent Innovation Demonstration Zones Nationwide, Article 4 (1) of No. 11 Document, prior to December 31st, such incentives shall not be calculated into the comprehensive income of the year and the taxation shall be independently calculated in accordance with this formula : the tax payable= income from incentive plan* tax rate-quick deduction
(iii) on the acquisition, holding and/or disposal of any underlying shares of securities; and
(a)If the participant directly holds the shares in the unlisted company, the income tax shall be calculated at the 20% tax rate of “property transfer income”.
(b) if the participant indirectly holds the shares of the unlisted company via one limited liability partnership, which is the method that most non-listed companies choose, the participant shall pay the tax at the tax rate of private proprietor, which is one 5%-35% progressive tax rate. Some regions in China have tax preference policies applying to the limited partnership registered within the region, which shall be one 20% preferential tax rate for property transfer income to natural person partners in a limited partnership.
(c) if the participant holds the shares of the domestic listed company, the taxation shall be waived upon transfer of the securities held by such participant; if the participants holds the shares of the overseas listed company, the income tax shall be calculated at the 20% tax rate of “property transfer income”.
No social security consequence.
(iv) in connection with any loans offered to participants (either by the company operating the incentive plan, the employer of the participant (if different) or a third party) as part of the incentive plan.
In taxation, if the company provides loan to participants, it is still paid in the name of participants when using the loan to purchase the shares. Therefore, the tax effect is the same as the above-mentioned.
No social security consequence.
What are the tax and social security consequences for companies operating an incentive plan?
(i) on grant;
No tax or social security consequence.
(ii) on vesting;
No tax or social security consequence.
(iii) on exercise;
Announcement of the State Administration of Taxation on Handling Enterprise Income Tax Involved in the Implementation of Equity Incentive Plan by Chinese Resident Enterprises (Announcement of the State Administration of Taxation No. 18 of 2012)
The listed company shall, in accordance with the Administrative Measures for the Equity Incentives of Listed Companies, establish an employee equity incentive plan. And in accordance with the relevant provisions of China's enterprise accounting standards, when the incentive plan is granted to the equity incentives, the fair price and quantity of the stock shall be calculated and determined as the listing company's cost or expense in relevant year, in exchange for the price of the incentive to provide services. For the above-mentioned enterprises that establish employee equity incentive plans, the enterprise income tax shall be implemented as follows:
(1) If the equity can be exercised immediately after the implementation of the equity incentive plan, the listed company may calculate the wage and salary expenses of the listed company in the current year based on the difference between the fair price of the stock and the actual exercise price of the incentive, and carry out pre-tax deduction according to the tax law.
(2) After the implementation of the equity incentive plan, it is necessary to exercise for waiting a certain number of years of service or to meet the stipulated performance conditions (hereinafter referred to as the waiting period). During the waiting period of the listed company, the relevant cost expenses calculated and confirmed by the accounting shall not be deducted when the enterprise income tax is calculated and paid in the corresponding year. When the equity of the equity incentive plan can be exercised, may calculate the wage and salary expenses of the listed company in the current year based on the difference between the fair price of the stock and the actual exercise price of the incentive, and carry out pre-tax deduction according to the tax law.
(3) The fair price at the time of actual exercise of the stock shall be determined by the closing price of the stock on the actual exercise date.
(4) For the resident companies listed outside China and non-listed companies, if the employee equity incentive plan is established in accordance with the Administrative Measures for the Equity Incentives of Listed Companies, and is handled in accordance with the relevant provisions of China's accounting standards in the accounting treatment of enterprises, the relevant enterprise income tax shall be implemented in accordance with the above provisions.
(iv) on the acquisition, holding and/or disposal of any underlying shares of securities;
No tax or social security consequence.
(v) in connection with any loans offered to participants (either by the company operating the incentive plan, the employer of the participant (if different) or a third party) as part of the incentive plan.
No tax or social security consequence.
What are the reporting/notification/filing requirements applicable to an incentive plan?
There are no mandatory reporting/notification/filing requirements applicable to an incentive plan. However, the following filing process are required for the taxation defer purpose:
- Where qualified stock incentives are offered by a unlisted company and individual income tax is paid on a deferred basis, the unlisted company shall, within the first 15 days of the following month from the exercise date of stock options, the elapse date of restricted stock, or the grant date of stock awards, submit to the competent tax authority the Record-filing Form for Deferred Payment of Individual Income Tax on Income from Stock Incentives of Non-listed Companies (Appendix I), the stock incentive plan, the resolution of board of directors or shareholders meeting, and information on the managerial or technical positions of the incentive recipients, as well as reports on the main business revenues of the company that offers the stock incentives and the target company of the stock awards.
- Where stock incentives are offered by a listed company and individual income tax is paid within 12 months, the listed company shall, within the first 15 days of the following month from the exercise date of stock options, the elapse date of restricted stock, or the grant date of stock awards, submit to the competent tax authority the Record-filing Form for Deferred Payment of Individual Income Tax on Income from Stock Incentives of Listed Companies (Appendix II). The listed company shall also submit the stock incentive plan and the resolution of board of directors or shareholders meeting when applying for initial record-filing for stock incentives.
Do participants in incentive plans have a right to compensation for loss of their awards when their employment terminates? Does the reason for the termination matter?
It depends on the company’s option incentive plan and the agreement signed between the company and the vestees The companies may have option repurchase arrangements for the participants when their employment terminates and they haven’t fully exercised their options or the vested Restricted Shares, but such arrangements would differentiate depending on the stage of the option (whether granted, attributed, exercised etc.) and on the reason for the termination (voluntary, involuntary, grave misconduct etc.). And when the court finds the conduct of the company is in violation of the Law on Employment Contracts or obviously lack of rationality, then the court may rule for the compensation to the participant. While it is difficult for the participants to receive such compensation if the options/ shares under incentive plan are deemed as independent from the employment package.
Yes, (1) if such employment is terminated due to fault or incompetence of the participants, then the participants don’t have the right to compensation for loss of their awards; (2) if such employment is terminated due to resignation, adverse change of the objective conditions, expiration of the medical treatment, lay-off, the compensation may be made in accordance with the agreement or the court decisions. When disputes arise between the vestee and the company for the matter of incentive option indemnification, such as when the parties at dispute do not reach an agreement on whether the vestee could receive the incentive equity shares or the indemnification fee, then such dispute may lead to overlapping application of labor laws or business laws and regulations such as the contract law or the company law, and the subject matter and the judicial institution may also vary. In practice, some cases are adjudicated as termination of labor relation and indemnification dispute case by the labor arbitration commission and the competent court; while some cases are adjudicated as equity dispute cases by the business arbitration commission or the competent court, depending on the dispute resolution provisions in the equity incentive agreement. Such variation makes the final judicial decisions of cases complicated and different from one another, so the dispute resolution strategy the disputing parties adopt is very important.
Do any data protection requirements apply to the operation of an incentive plan?
No specific data protection requirements apply to the operation of an incentive plan.
For listed companies, the details of the incentive plan, including the vestee, the amount of the incentive equity and the pricing should be disclosed to the public; while most unlisted companies shall keep the details of the incentive plans wholly or partly confidential.
Are there any corporate governance guidelines that apply to the operation of incentive plans?
Yes, the following corporate governance guidelines generally apply to the operation of the incentive plans,
- Company Law of the People's Republic of China
- Securities Law of the People's Republic of China
- Administrative Measures for the Supervision over Unlisted Public Companies
- Guidelines on the Implementation of Employee Stock Ownership Plans and Stock Option Incentives by Pilot Innovative Enterprises
- Announcement of the State Administration of Taxation on Handling Enterprise Income Tax Involved in the Implementation of Equity Incentive Plan by Chinese Resident Enterprises
- Circular of the State Administration of Taxation on Issues Concerning Individual Income Tax in Relation to Equity Incentives
Are there any prospectus or securities law requirements that apply to the operation of incentive plans?
There are no formal securities law requirements apply to the operation of the incentive plans in the non-listed companies for now; while for the listed-companies , the following laws and regulations apply to the operation of the incentive plans,
- Administrative Measures for the Equity Incentives of Listed Companies
- Trial Implementation Measures for the Implementation of Equity Incentives by the State-owned Controlling Listed Companies (Domestic)
- Circular of the State-owned Assets Supervision and Administration Commission of the State Council and the Ministry of Finance on Issuing the Interim Measures for Implementing Equity Incentive Plans by State Holding Listed Companies (Oversea)
- Notice on Regulating State Holding Listed Companies Equity Incentive Scheme
Do any specialist regulatory regimes apply to incentive plans?
A. Industrial regulations
- Main board information disclosure business Memorandum No. 3 – Share incentive and employee stock holding plan
- Small and Medium Enterprise Board information disclosure business Memorandum No. 4 – Share incentive
- Growth Enterprise board information disclosure business Memorandum No. 8 – Share incentive plan
- Growth Enterprise board information disclosure business Memorandum No. 20 – Employee share holding plan
- Growth Enterprise board information disclosure business Memorandum No. 8 – Share incentive plan
- Shanghai Stock Exchange Notice on matters regarding Share incentive plan stock option exercise
- Business Memorandum of Information Disclosure Issued by Shenzhen Stock Exchange No. 8 - Registration for Granting of Equity Incentive Stock Option
- Business Memorandum of Information Disclosure Issued by Shenzhen Stock Exchange No. 9 - Confirmation for Exercise of Equity Incentive Stock Option
B. State-owned companies regulations
- Opinions on the Implementation of the Pilot Employee Stock Ownership Program by State-controlled Mixed Ownership Enterprises
- Interim Measures for Equity and Dividend Incentives of State-Owned Technological Enterprises
- Guiding Opinions on Pilot Programs of Equity-based Incentives for State-owned High-tech Enterprises
- Opinion on regulating State-owned company employee shareholding and investment
Are there any exchange control restrictions that affect the operation of incentive plans?
Yes if the operation of such incentive plan applies to foreign exchange and the following regulations shall be applied,
- Administrative Regulations of the People's Republic of China on Foreign Exchange applies to foreign exchange receipts and disbursements and to the foreign exchange business activities of domestic organizations and individuals, foreign organizations, and foreign individuals.
- Individuals shall follow the Administrative Measures for Individual Foreign Exchange in handling relevant foreign exchange business.
- Circular of the State Administration of Foreign Exchange on Issues concerning the Administration of Foreign Exchange Used for Domestic Individuals' Participation in Equity Incentive Plans of Companies Listed Overseas provides that individuals participating in the equity incentive scheme of the same overseas listed company shall, through their domestic companies, centrally entrust a domestic agency (hereinafter referred to as the domestic agency) to conduct the matters such as foreign exchange registration, opening of accounts and the transfer of funds and exchange, and shall appoint a foreign agency (hereinafter referred to as the foreign agency) to conduct the matters such as individual exercise of the option, purchase and sell corresponding share or equity and related capital transfer. If the incentive recipient conforms to the requirement of option exercise exercised the option, the recipient shall set up an account abroad and pay the company the full consideration of the incentive option and tax and expenses. In practice, when the company repurchases the restricted stock or option, it will pay the repurchase price to the individual account of the incentive recipient through the overseas SPV, and the incentive recipient, as an individual, needs to file for the foreign exchange registration procedure according to Circular of the State Administration of Foreign Exchange on Issues concerning Foreign Exchange Administration over the Overseas Investment and Financing and Round-trip Investment by Domestic Residents via Special Purpose Vehicles (hereinafter referred to as "circular 37th"), and complete the foreign exchange settlement procedures through the filing of circular 37th.
What is the formal process for granting awards under an incentive plan?
- The board of directors and board of shareholders or otherwise authorized institutions shall make the rules of the incentive scheme, the management (mainly the founders) decides on the recipient, quantity, HR department or directors office should assist in the implementation of the scheme. For most companies, the lawyers will assist in the drafting of the relevant legal documents of the equity incentive plan.
- The company and the recipients enter into the option award agreement and relevant documents.
- The company's board of directors or designated awarding institution assists the execution of the option award when the recipient’s option is vested.
- The recipients of the option pay the exercise consideration and obtains the corresponding option. In practice, for unlisted companies, some will choose to register the equity incentive matters with the competent AIC upon vesting or exercising, while some will choose to entrust the founder or some management official to hold the incentive equity shares and register such shares with the competent AIC when the company is merged, under stock system restructuring or in process of application for IPO.
Can an overseas corporation operate an incentive plan?
- Some Chinese companies will establish red-chip structure for financing or oversea listing, which is the equity structure that the controlling company is registered in overseas region but the operating entity is registered domestically, especially the companies in the technology, media and telecom (TMT) industry. Under the red-chip structure, the equity incentive plan is usually implemented in the oversea controlling company. In this case, the employees of the overseas corporation or its related parties could participate in the incentive plan duly approved by its board of directors, subject to the applicable exchange control laws and regulations.
Can an overseas employee participate in an incentive plan?
Yes. In case there will be any doubt, we assume here overseas employee refers to foreign natural person (the situation for natural person from Hong Kong, Macau and Taiwan is more complicated since they are regarded as foreigners in some cases and not foreigner when there are specific policies, so such situation will not be discussed here.
In the unlisted company, the overseas employee could participate in the incentive plan, however, the exercise of the incentive plan may lead the nature change of such company, i.e. from one limited liability company into one joint-venture, and the related industry access for foreign investment shall be applied. If the company carrying out the equity incentive plan falls into the “restricted” category for foreign investment, then the incentive plans for foreign natural person should satisfy government approval requirement; if the company carrying out the equity incentive plan falls into the “prohibited” category for foreign investment, then incentive plans cannot be vested to foreign natural person.
While for the listed-company, on August 15th, 2018, the CSRC reviewed and adopted amendments to Administrative Measures for the Equity Incentives of Listed Companies and Administrative Measures on the Registration and Settlement of Securities. Under the amended measures, foreign employees involved in equity incentives are no longer limited to employees working domestically. Foreign employees working abroad are also included in the range of objects that can be subject to equity incentives. Foreign employees work abroad allowed to participate in equity incentives can also open A-share account and Foreign employees' A-share securities accounts are no longer limited to holding and selling, and are no longer prohibited from "engaging in other securities trading activities" (such as increasing their holdings). In conjunction with this, China Securities Depository and Clearing Corporation Limited issued Circular on Matters Concerning the Opening of A-share Securities Accounts by Qualified Foreigners, which clarifies the scope of foreigners who can open A-share securities account and the application materials required to open an account. From September 15th, 2018, foreign nationals working domestically may apply for account opening in accordance with the requirement in this notice.
How are share options or awards held by an internationally mobile employee taxed?
Individuals who do not have a domicile in China may obtain wages and salaries in the form of subscribing securities such as stocks at a discount after they work in China or after leaving China. The above income should still be based on the principle of the place where the labor is incurred to determine its source of origin and tax liability. The above-mentioned individuals who obtain wages and salaries in the form of subscribing securities such as stocks at a discount after they come to china, anyone who can provide the wage system and the measures of subscribing securities at a discount in the employer and prove that a part of the above income comes from the work before the individual came to China, they can levy personal income tax only on income that is part of their work in China. Correspondingly, the income received after leaving China, by the above-mentioned individuals who have stopped performing or performing their duties in China, should also be determined to be derived from our country’s income. However, if the above-mentioned income is not borne by enterprises or institutions or places within the territory of China, the individual income tax may be exempted.
The stock option income obtained in China is subject to individual income tax as listed in question 7.
How are cash-based incentives held by an internationally mobile employee taxed?
- The mainly cash-based incentives to mobile employees is bonus. Before 31 December 2021, there is a special preferential tax policy for the annual one-off bonuses, which will be treated as a separate one-month pay when calculating the tax payable, and not included in the comprehensive income of the year. Specifically, the annual one-off bonuses will be divided in the very month by 12 months first, then determining the applicable tax rate and the sum of quick calculation deduction according to the quotient.
- Besides, there are some tax-free incentives to mobile employees, including house allowance, relocation allowance, the expenses of visiting family (travel fee from China to his/her home), language training (Chinese only) expense and children education expense. Law or regulation does not provide specific amount/cap on those items, in practice, the amount of them shall be reimbursed based on actual expenses with invoice.
According to Cai Shui  No. 164, foreign employees can choose to enjoy either special additional deduction or continue to enjoy the tax free preferential policy for subsidies for housing, language training, children education etc.
What trends in incentive plan design have you observed over the last 12 months?
(i) For the incentive plan within China, more companies tend to consider the possible impact of the taxation in the incentive plan design and try to bring tax planning into the incentive plan.
(ii) For red-chip structured companies, more companies tend to use trust for the incentive plan, for the benefits of mobility and tax preferences, especially after effectiveness of the anti-individual income tax circumvention regulations are carried out after January 1st, 2019.
(iii) In the light that more dispute cases emerger due to the ambiguity and irrationality of the of the equity incentive and equity distribution rules and brig adverse effects on the company’s operation and development, increasing number of companies choose to hire professional lawyers in assisting in making their equity incentive plans and drafting relevant legal documents. Meanwhile, there are more and more consulting companies and lawyers with the expertise to assist the clients in equity structure design and execution.
(iv) More companies tend to care the actual effect of the incentive plan and wish to connect the incentive plan with the company operation, compensation benefit package, the employee performance, the non-competition after termination of the employment , etc.
(v) As for the overlapping application with regard to the labor law and business law as mentioned above, local counts incline to treat incentive plan as one kind of the compensation benefit package and should be governed by the labour dispute chamber of the court and the Law on Employment Contracts and its principles should be applied and incline to protect the interest of the employees.
What are the current developments and proposals for reform that will affect the operation of incentive plans over the next 12 months?
Individual Income Tax Law of the People's Republic of China was revised and adopted in 2018 and the tax payment method was adjusted, which shall bring enormous effect on the taxation treatment of the incentive plan.